Digital Currencies & Monetary Policy in the Digital Age
We have explored the significant qualities of money from a historical perspective and also looked ahead to the future of financial technologies such as cryptocurrencies and central bank digital currencies (CBDCs). Now, we delve into a snapshot of monetary policy concerning digital currencies, focusing on the effects of cryptocurrencies, stablecoins, and CBDCs. Cryptocurrencies, due to their low adoption and perceived lack of intrinsic value (moneyness), are unlikely to impact monetary policy in the near term. Conversely, stablecoins have the potential to reach critical mass, especially if supported by large corporations like BlackRock managing cash reserves for the $50 billion stablecoin USDC. CBDCs represent a publicly accessible digital version of national currency with significant implications for monetary policy and financial stability. Although central bankers currently see limited monetary policy incentives or are concerned about potential financial disruption, more than 80% of central banks are contemplating CBDC launches or have already done so.
We’re unraveling the intricacies of money’s evolution, tracing its history and envisioning its future to comprehend present constraints through the lens of regulation and its multifaceted aspects.
Research into CBDCs holds immense significance as it shapes the trajectory of the 21st century. With technology influencing the economic landscape, monetary policy stands at a crucial juncture. CBDCs, much like other cryptocurrencies, must not pose harm and should avoid becoming sources of financial turbulence that hinder global monetary policy transmission. As nations consider the introduction of CBDCs, thoughtful analysis should guide policy choices and design decisions.
The 2021 Global Crypto Adoption Index by Chainanalysis reported an over 880% surge in worldwide crypto adoption, driven by P2P platforms enhancing cryptocurrency utility in emerging economies.
Over two decades ago, when the Internet gained widespread accessibility, prominent economists and central bankers speculated whether advancements in information technology could render central banks obsolete. While those predictions have yet to fully materialize, the growth of crypto assets has revived the discourse. These assets could potentially serve as payment methods and units of account, reducing reliance on fiat currencies and central bank money. It’s time to re-evaluate the question of whether monetary policy remains effective in the absence of central bank money.
Is Monetary Policy Limiting Adoption?
To this day, the monetary policy implications of cryptocurrencies remain notably limited. This is evident in their relatively small share of the global market capitalization when compared to traditional monetary aggregates. Due to their current low level of acceptance, which is gradually increasing, and considerable volatility, this perspective is unlikely to change in the immediate future (although discussions are becoming more constructive). In terms of financial stability, cryptocurrencies have not posed significant concerns, as the financial services sector’s exposure has been modest. However, this scenario might shift in the near future depending on legislative developments. This transformation is already underway, exemplified by Coinbase‘s initial public offering and the growing investments in the field. As the industry becomes more interwoven with the fabric of global economics, the potential for systemic risk increases.
Nevertheless, ongoing technological advancements might offer solutions to some of these drawbacks. Central banks must persist in implementing effective monetary policies to counter potential competitive pressures from crypto assets. Additionally, they can leverage the attributes of crypto assets and their underlying technology to enhance the attractiveness of fiat currencies in the digital age.
Exploring the Potential Benefits of Cryptocurrency for the Monetary System
Due to their limited supply, certain crypto assets, like Bitcoin, possess a low risk of inflation. However, they lack three crucial functions expected of stable monetary systems: insulation against structural deflation, the capacity to flexibly respond to transient shocks in money demand for regulating the business cycle, and the ability to act as a lender of last resort. With this perspective in mind, let’s consider the following: Can Special Drawing Rights (SDRs) be issued via blockchain? Could an intelligent AI capable of algorithmically assessing the systemic risk described by Dora Haraway as “the detumescing project of a self-making and planet-destroying” Homo sapiens prevent impending doom? The answers lie beyond our current reach.
Crypto assets offer advantages as mediums of exchange, combining the anonymity of cash with the ability to conduct transactions across vast distances and using more divisible transaction units. Particularly in the sharing and service-based digital economy, crypto assets prove appealing for microtransactions.
Distinct from bank transfers, crypto asset transactions can be rapidly cleared and settled without intermediaries. This advantage shines in cross-border payments, notorious for being expensive, time-consuming, and opaque. By bypassing correspondent banking channels, emerging services based on distributed ledger technology and crypto assets have slashed cross-border payment delivery times from days to mere seconds.
Hence, the possibility remains that select crypto assets might gain broader adoption and perform more monetary functions in certain regions or private e-commerce networks in the future.
Furthermore, the rise of crypto assets and growing acceptance of distributed ledger technology could signal a shift from account-based to value or token-based payment systems. Account-based systems involve claims being recorded by an intermediary like a bank. Value or token-based systems, however, rely on the direct transfer of a payment object, like a commodity or paper currency. The transaction’s success depends on validating the value or authenticity of the payment object, irrespective of trust in intermediaries or counterparties.
This transition could herald a change in how money is conceptualized in the digital age, shifting from credit-based money to commodity-based money, reminiscent of historical epochs like the Renaissance. While money largely rested on credit connections in the 20th century – with central bank money representing credit relationships and commercial bank money indicating credit links between banks and customers – crypto assets deviate by not embodying credit relationships, akin to commodity money in nature. Debates among economists continue over the origins of money and the shifts between commodity and credit money throughout history. If crypto assets indeed amplify the role of commodity money in the digital era, demand for central bank money is anticipated to decline.
But the central question remains: would this shift significantly affect monetary policy? Would reduced demand for central bank money complicate efforts to control short-term interest rates? Economists disagree on whether substantial alterations to central bank balance sheets would be necessary to manipulate interest rates in a landscape where central bank liabilities no longer function for settlements. In a crypto-centric realm, would the central bank need to acquire and sell numerous crypto assets to influence interest rates?
Regardless of the disparities, the overarching concern remains consistent: the primary query concerning such a scenario is the extent to which central banks’ monetary actions would hold relevance. Essentially, if central bank money no longer serves as the unit of account for most economic activities, with crypto assets assuming that role, the efficacy of central bank monetary policy becomes irrelevant.
What Should Central Banks Do in This Situation?
How can they shield fiat currencies from the competitive forces that crypto-assets might introduce? Initially, efforts should persist in fortifying fiat currencies as dependable and steadfast units of account – the cornerstone of the monetary framework.
Technological advancements can also bolster monetary policymaking: harnessing big data, artificial intelligence, and machine learning, central banks can elevate their economic projections. While the ramifications of Central Bank Digital Currency (CBDC) for monetary policy, transmission, and financial stability are apparent, the discourse has yet to focus substantially on monetary policy intricacies.
Unlike cryptocurrencies and stablecoins, a CBDC, denominated in the official currency unit, would be issued by the central bank. While reserves exist in digital form, their full accessibility is limited as they can only be maintained within central bank accounts held by banks. Presently, the only central bank asset accessible to anyone is banknotes, which remain non-digital.
The impact of CBDC on monetary policy and financial stability hinges on its adoption speed and breadth. Design elements of CBDC hold pivotal importance in this context as they define its appeal and consequently shape prospective demand. Nonetheless, perspectives diverge on whether CBDC is necessary or favorable in terms of monetary policy or financial robustness. Mounting evidence underscores the complexity of this stance for two key reasons. Firstly, the risks that CBDCs pose to bank intermediation heavily hinge on central banks’ decisions.
Secondly, the issuance of CBDCs could bestow widespread advantages upon the entire financial system.
As the demand for cash wanes, the issuance of CBDCs could ensure that sovereign money remains pivotal in upholding trust in the monetary and payment infrastructure. A CBDC would preserve the value of money and monetary autonomy by perpetuating the provision of the benchmark value for all forms of privatized money in circulation. Dominant network externalities can confer monopoly authority upon private payment networks, a phenomenon that central bank digital money could help mitigate.
Central banks are poised to assume a pivotal role in shaping the forthcoming macrofinancial landscape, encompassing the integration of digital money and its potential impact on the existing fiscal system. Consequently, whether our interests align with fiat, cryptocurrencies, NFTs, or more, we are all intricately tied to the impending decisions of central banks. This discussion holds relevance for all of us, underscoring the widespread implications of future choices, whether we are stakeholders in traditional currency or emerging financial paradigms.